We recently did a blog post on Intentionally Defective Grantor Trusts (IDGT). We can use these trusts to gifts assets during lifetime to the next generation with some additional estate planning opportunities.
However, one of the biggest drawbacks to the IDGT is that the assets are no longer ours. We have irrevocably transferred control of the assets to the next generation(s) and we may be concerned that not enough income is available for our support until death.
A Spousal Lifetime Access Trust (SLAT) can help solve this issue. It is very similar to an IDGT in that the income of the trust is taxed to the donor during lifetime, however, the assets are “gifted” to your spouse. The gift of the assets to your spouse removes the assets from your estate; your spouse has access to both income and principal; and credit protection is provided usually via adding a trust “protector” to the trust and using spendthrift clauses in the trust agreement. Distributions from the trust to the spouse can then be shared with donor spouse.
The SLAT has the same drawback of an IDGT in that there is no step-up in basis on assets transferred into the trust. Therefore, the best assets to place into the SLAT would be assets that may not need much of a step-up such as farmland that will remain in the family for many generations. You can design the SLAT to last for generations with each generation receiving income distributions but not having the assets be included in each generation’s estate. We commonly call this a dynasty trust; however, realize after multiple generations there my be hundreds of beneficiaries receiving income off of 1,000 acres. That may not make much sense from an administration standpoint.
Farmers who live in a state with an estate tax such as Oregon, Illinois, Minnesota, Washington, etc. may also benefit since these assets are now removed from estate taxation in those states.
We typically need to structure the gift by the donor of separate property owned by them. Joint or community property does not work well. For those in a community property state will need additional guidance from their estate tax advisors.
There are two main risks associated with the SLAT. One is the death of the donee spouse since the donor spouse no longer has any access to the trust to live on, etc.. This can be mitigated by purchasing a life insurance policy on the donor spouse in an irrevocable life insurance trust (ILIT).
The other risk is divorce. If the spouse divorces the donor, then the assets of the trust will be for the benefit of the ex-spouse. There are a couple of options to remove this risk. First, the trust agreement can use the concept of the “floating spouse”. This means that the beneficiary must be married to the donor in order to qualify for any distributions. This removes the ex-spouse from the trust at that time. Second, you may add a clause that allows an independent trustee or trust to protector to add a lineal descendent of the donor’s grandparents to the trust. In other words, the donor. This allows the donor to be added to the trust as a co-beneficiary in the case of a divorce.
Finally, we typically see two SLATs. One for each spouse. However, we have to make sure that each SLAT is not too much alike. If they are too similar, the IRS will argue that the donors have not really made an actual gift. To remove this risk, we make sure that each trust is different from the other. Options to achieve this are as follows:
- Form each trust in separate states – Perhaps one in South Dakota and one in Nevada. Both states have various trust income tax benefits and domestic asset protection statutes.
- Have different “dispositive” provisions. One trust will grant a limited power of appointment to the spouse to divide the assets among the heirs. The other trust will state the descendants will receive property at a certain age (35, 40, etc.).
- You may name different beneficiaries – One may pass assets to children and the other passes assets to grandchildren.
There are many ways to make sure the trusts are not the same.
With less than 4 months remaining in 2021, it is important to understand how to use IDGTs, SLATs, and other trusts to properly transfer assets to the next generation. The SLAT is likely one of the best options to allow farm couples to retain “income” but keep the assets out of their estate.
This is a very complex subject and you need to review with your estate planning advisor.
This blog contains general information and does not constitute the rendering of legal, accounting, investment, tax, or other professional services. Consult with your advisors regarding the applicability of this content to your specific circ*mstances.
